Decidedly unheroic results from Hero

The 3.6% increase in average realization per vehicle could do nothing to save profitability. Photo: Ramesh Pathania/Mint

Updated: Thu, Jan 17 2013. 11 59 PM IST

Investor faith in the country’s largest motorcycle maker, Hero MotoCorp Ltd, has been shaken. Earlier in the month, a 1% contraction in December quarter’s sales volumes when compared with a year ago, coupled with a significant drop in market share to competition, had set the stage for lower expectations. But the 20.4% year-on-year(y-o-y) drop in net profit to Rs.487.9 crore has quashed analysts’ hopes of a better outlook on grounds that a better winter agricultural harvest (rabi crop) would lift demand from rural areas. It was a significant 17% below Bloomberg’s consensus estimates.

The biggest jolt was a precipitous drop in operating margin to 12.6%—305 basis points (bps, or 3.05 percentage points) from a year back and 128 bps even compared with the preceding quarter. Cost pressures by way of higher raw material to sales expenses and a little over a Rs.100 crore jump in advertising expenses to promote new models from its stable ate into income earned. The 3.6% increase in average realization per vehicle could do nothing to save profitability.

Operating profit plunged, too,—by 17.5% from the year-ago period to Rs.778.7 crore, although it was marginally higher than the September quarter

The management, in its analysts’ conference call, reportedly attributed the fall in profits to new products with a higher raw material cost and ad-spending and conceded that profit margins are lower on some new launches. The change in product mix will only get reinforced going forward, which will, in turn, put to test the company’s ability to rev up profitability to higher levels. Although employee costs as a percentage of sales rose very marginally, this could rise in the future, as media reports suggest that wage negotiations are round the corner.

Hero MotoCorp’s shares have been on a downhill path since April as competition has challenged its historic market leadership and brand equity. The stock has underperformed leading benchmark indices and that of its closest competitor Bajaj Auto Ltd, which has maintained profitability, thanks to its diversified product mix, which includes three-wheelers. According to Yaresh Kothari, automobile analyst, Angel Broking Ltd, “We lower our earnings expectations for FY2013/14 by 11.4%/9.3% mainly due to lowering of our volume expectations… and operating margin..” The stock could fall further unless the March quarter brings back profitability as its new launches stabilize and if demand for two-wheelers as a whole improves.